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How will California's cap-and-trade emissions-reducing program work?

Emissions-producing diesel trucks and cars pass non-polluting windmills along the 10 freeway on December 8, 2009 near Banning, California.
Emissions-producing diesel trucks and cars pass non-polluting windmills along the 10 freeway on December 8, 2009 near Banning, California.
David McNew/Getty Images

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Today, California takes a giant step forward in its effort to curb green house gases as the state is officially launches its "cap and trade" carbon market.

Under this new system, businesses will have to limit how much carbon they put into the atmosphere; That's the cap.

If they plan to go over their allotted amount, they'll have to buy carbon credits from a business that already cut their emissions; That's where the trade comes in.

To explain how this new market will work, we've enlisted the help of KPCC's environmental reporter Molly Peterson and business blogger Matt DeBord:

Molly: Alright Matt, before we get all businessey - your favorite part - let's talk about where this cap-and-trade market came from.

Matt: Sounds good, Molly. Hit me with the history.

Molly: Remember back in 2006 when California passed AB 32?

Matt: That was so long ago!

Molly: That law was designed to cut down California's green house gas emissions. The big goal is to have 1990 levels of carbon output by the year 2020.

Matt: Very ambitious.

Molly: It's taken six years to get this up and running because the state was very careful, trying to be when designing the system. There's also been a number of legal challenges. The most recent was just yesterday. 

Matt: Now California is ready to get this market started. And to make it happen, more than 400 companies that operate in California and crank out carbon, will have to start cutting their pollution by 2 to 3 percent every single year. At first, it'll be just electrical companies and large industrial facilities. But in three years, California will add big carbon belchers like oil refineries to the list.

Molly: So how do you help motivate businesses to shrink their carbon footprints?

Matt: You turn going green into something they are much more familiar with, a market.

Molly: And that's where the cap-and-trade market comes in. Now to explain how the trading on this carbon market will work, we're going to have to call up memories of grade school.

Matt: Cue the school yard. 

Molly: Okay, if you ever had P.E. class on a rainy day, you played musical chairs. Or else that's just what we did in the gym at my grammar school.

Matt: I always used to lose that game.

Molly: Well, remember a game of musical chairs, at the start of the game, everybody has a seat. But then everyone stands, you take away one chair, and play the music.  

Matt: When the music stops - one person is left with no place to sit. This goes on again, music stops, another person loses their seat and on and on. 

Molly: This is essentially what the carbon market will be like. But think of the chairs as carbon allowances. Remember, that's what gives businesses permission to pollute.

Matt: So the people looking to sit in those chairs are the companies. The first year the companies won't have to cut their emissions by that much. So it's like everyone getting a chair.

Molly: But year after year - companies will have to keep dropping their carbon output. Eventually, some won't be able to keep up, because the state is going to keep removing chairs from the game. 

Matt: Now in the carbon market, if you can't cut your pollution fast enough, you can buy the right to pollute more from a company that doesn't need to use its carbon allowance.

Molly: It would be like someone with a chair deciding they might as well just stand. So instead of playing they sell you their chair so you can stay in the game.

Matt: As the game goes on, these carbon allowances, or chairs, are going to get more and more valuable. It's simple supply and demand. As the supply of allowances dwindles, the price will go up.

Molly: So Matt, businesses have been saying for years that their cost will go up if they have to buy these allowances and ultimately, that will drive up prices for the consumer, right?

Matt: Well, not exactly. At least, if you ask Gary Gero, he's the head of the Cimate Action Reserve, one of the groups that helped design the carbon market. 

Gary: So if we get cap-and-trade rights, people won't notice because we are doing this in a way that is the most economically efficient possible.

Matt: The theory is that this market will force companies to invest in cutting their carbon footprint, that may cost more at first, but eventually it'll lead to more savings and they'll pass that onto consumers. 

Molly: Alright, back to the carbon market. Today the states dolling out these allowances, most their giving away free of charge, some their selling.  And these could net anywhere from half a billion to a billion dollars.

Matt: But, Molly, you know who is getting really excited about this?

Molly: The regulators who just spent sixty years making this thing?

Matt: No, professional traders. They love this! It's a whole new thing to trade! California will set the initial price of these carbon credits, after that, it's up to the market. That means investors can buy these credits early when they are relatively cheap and hold on to them until they are in higher demand.

Molly: That one, I know. Buy low, sell high.

Matt: Exactly. Now, California's market will be small compared to an international market, like the one in Europe. But I spoke with Ricardo Bayon, he's a banker who plans on investing in this market. He told me, investors are still very excited.

Ricardo: California, however, is big. And big enough to have an impact. And big enough to create a market that is sizeable and interesting. And I think will achieve the state of environmental end, which I think is a very important aspect of this. 

Matt: So there's more than one shade of green at play here in the carbon cutting business.